The collapse of Lehman Brothers and the takeover by Bank of America of Merrill Lynch has left bankers, traders and analysts looking for signs of stress and weakness elsewhere in the sector.

The market had been looking for signs of problems among the brokers since Bear Stearns was bailed out six months ago by JP Morgan Chase. The broker-dealer model, which relies on earnings from investment banking and does not have the luxury of a retail deposit base, has come under pressure again in recent weeks.

The fall of Lehman Brothers meant attention was always likely to turn to what the market perceived was the next weakest firm. Concerns centred quickly on Merrill Lynch, which had taken the largest writedowns of the four big US brokers and has raised less capital as a proportion of its losses than other banks.

Its shares had dropped 36% last week as investors digested news that Lehman Brothers had failed to find a strategic investor and rushed out the publication of worse-than-expected third-quarter results. With bankers and officials from the Federal Reserve anxiously watching from the sidelines, Bank of America moved in.

Lehman Brothers and Merrill Lynch were not however the the only banks under pressure last week. Shares in Morgan Stanley fell 10% last week, while Goldman Sachs dropped 5.5%.

The FTSE Eurofirst 300 financials index fell by 5.3% in early trading today and stood at 960.86 at 09.40 BST today compared with a drop of 3.5% for the FTSE Eurofirst 300 index for all sectors.

In the UK, the FTSE 100 fell by 3.6%, compared with a 3.3% fall in Germany’s Dax 30 index and a 4.2% fall in France’s Cac 40 index also at 09.40 BST. Financial markets in Japan, China, Hong Kong and South Korea are closed today for a public holiday.

The crisis, which came a year after the collapse of UK lender Northern Rock and in the week in which writedowns and losses from the credit crisis broke through the $500bn mark, has also rippled through the credit derivatives markets.

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Since the beginning of last week, five-year senior CDS spreads on Lehman Brothers had risen by 130% to 775 basis points. The cost of insuring against the risk of Merrill Lynch defaulting has jumped 40% to 435bps – around double the levels at Goldman Sachs and Morgan Stanley, according to data from Markit. The CDS on Merrill Lynch are trading at the same level as those on Lehman Brothers 10 days ago.

One senior capital markets banker at a European bank in London said the cost of credit for broker dealers is at “exorbitant levels”, even compared to banks. He said: “There comes a point when their models do not work. There is no way brokers can lend to the corporate sector when funding costs are this high, and without that, there is little business from cross-selling products either.”

A prominent banks analyst at a US bank, speaking before its takeover, said: “Merrill Lynch has taken big marks and raised huge amounts of equity, but we don’t know how much more it will need. We can only hope and pray they have raised enough.” Merrill Lynch has made $52.2bn in writedowns and raised $29.9bn in capital since last summer, the lowest ratio of capital raised to losses taken, according to Bloomberg data.

Chief executive John Thain and chief financial officer Nelson Chai had assured investors that the bank had sufficient liquidity. But some market participants were already growing concerned over its capital ratios. For example, its Tier 1 capital ratio of 7.6% and its total capital ratio of 12.2% at the end of June are both lower than the equivalent ratios at Lehman Brothers a month earlier.

Option traders were also highly active in Merrill Lynch put options last Friday, as the shares traded at a 52-week low. Implied volatility, a measure of how volatile the market expects a stock to be over the next 30 days, jumped to 181.0% in afternoon trade, against 86.8% 12-month historic volatility.

Traders have bought large volumes of puts on the US brokers ahead of September’s expiry next week. The open interest of put options was up 33% on Lehman Brothers since the beginning of the month, and between 9% and 10% on the remaining three brokers.

Lehman stock on loan to be borrowed by short sellers rose to 17% last Wednesday, the latest date available, up from 11% a week earlier, according to UK analysis firm DataExplorers. The proportion of stock on loan at Morgan Stanley, Goldman Sachs and Merrill Lynch was steady this week at just over 2% in each case.

Analysts are also watching for signs from the rating agencies over how they will look at the other brokers, after Moody’s Investors Service and Standard & Poor’s put Lehman on review for a possible downgrade last week. In response to a question on what level of capital Lehman would need to have for Moody’s to be comfortable, Blaine Frantz, senior vice-president at the agency said: “It is not simply going to be a matter of sufficient capital coming out of the box. These are highly confident sensitive institutions, and frankly no matter how much capital they raise, if they fail to gain the confidence of the marketplace, it doesn’t matter.”

In the past few weeks, analysts have been cutting their earnings forecasts on the sector. Analysts have slashed third-quarter earnings per share forecasts at Goldman Sachs by 40% in the past four weeks, according to Bloomberg, amid fears that the US bank’s trading business has suffered over the summer. Goldman Sachs is due to report earnings on Wednesday. Analysts have also cut their forecasts for Morgan Stanley by 11%, and increased their forecasted losses at Merrill Lynch by 10%.